by Justin Spittler, Casey Research:
Stocks are rallying for a bizarre reason.
Two weeks ago, the S&P 500 set a new all-time high. It was its tenth new high since July 11.
What’s more, stocks are rallying despite nearly impossible odds:
The global economy is stalling. The U.S., Europe, Japan, and China are all growing at their slowest rates in decades.
Stocks are expensive. According to the CAPE valuation ratio, U.S. stocks are 62% more expensive than their historic average. CAPE gives a long-term view of the S&P 500.
Worst of all, corporate profits are plunging. Earnings for companies in the S&P 500 are on track to decline for the fifth straight quarter. That hasn’t happened since the 2008–2009 financial crisis.
Normally, periods of falling earnings have led to bear markets. That’s because earnings are the most important driver of stocks.
According to The Wall Street Journal, the S&P 500 has historically been about 90% correlated with earnings. In other words, stocks and earnings are supposed to move together.
But right now, stocks are rising while earnings decline.
This year, the correlation between the S&P 500 and its earnings has turned negative, to about -0.20.
Today, we’ll tell you what reckless behavior is fueling the stock market. As you’ll see, this can’t keep stocks afloat for much longer. We’ll also show you how to protect yourself from this dangerous situation.
• Investors are “reaching for yield”…
For the last eight years, the Federal Reserve has held its key interest rate near zero.
The Fed cut rates during the financial crisis to get folks to borrow and spend more money. According to the government’s flawed economic models, this would grow the economy.
It hasn’t worked. The U.S. economy is “recovering” at the slowest pace since World War II. Last quarter, the economy grew just 1.2%, less than half its historic growth rate.
• The Fed also made it very hard to earn a decent return…
You see, the Fed’s key rate sets the tone for all other interest rates.
By holding its key rate near zero, the Fed made it incredibly cheap to borrow money. It also made it difficult to earn a decent return in the bond market.
Take the 10-year Treasury. From 1962 to 2007, 10-years paid 7.0% in interest. Today, they yield just 1.6%.
Corporate and municipal bonds also pay about half of what they did nine years ago.
These days, you need to own risky assets to have any chance at a decent return.
• Investors have piled into stocks that pay dividends…
The Dividend Aristocrats Index, which tracks companies that have increased their dividends for at least 25 consecutive years, has climbed 275% since March 2009. The S&P 500 is up 221% over the same period.
According to The Wall Street Journal, dividends have become a driving force of the stock market:
The five-year rolling correlation between S&P 500 companies’ dividend yield and the index’s performance has been at 0.80 or above for the five quarters through June, according to S&P Global Market Intelligence. That is the highest since 1993 and up from an average of minus-0.1 dating back to 1941.
Keep in mind, the correlation between earnings and stocks has plunged to -0.2. This means dividends have more impact on stocks right now than earnings. This is almost unprecedented.
Since 1941, the correlation between stocks and dividends has been -0.1, meaning they’ve had almost no impact on the performance of the S&P 500 for the past 75 years.
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